Sunk by a Rollover

By Andy Ives, CFP®, AIF®
IRA Analyst
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Unfortunately, it happened again. Another person dove into the IRA rollover pool before checking the depth, temperature, or if the pool was even open for swimming. In this scenario, $125,000 was rolled from an IRA at Bank A to Bank B. A few months later, in a constant search for a higher paying certificate of deposit, the account owner rolled the same $125,000 to an IRA at Bank C.

Spot the problem(s)? This relatively innocuous-looking transaction created a laundry list of snowballing issues. Probably the most penal is that the second rollover attempt was invalid and is treated as a distribution. The $125,000 is now taxable earned income for the year. Why? A person is permitted only one (1) 60-day rollover per 12-month period with their IRA accounts. This does NOT mean one rollover per calendar year. You must wait 365 days before you can do another 60-day rollover. Also, it would not matter if the person in the above example rolled over different IRA funds from Bank B to Bank C. For the one-rollover-per-year rule, all traditional IRAs and Roth IRAs owned by the same person are aggregated.

Some rollover transactions can be done an unlimited number of times each year, including rollovers from employer plans to IRAs, rollovers from IRAs to employer plans, and Roth conversions. However, none of these fit the situation above. How could the money have been properly moved? Either a direct transfer from Bank B to Bank C (i.e., ACH/wire) or a check, payable to the IRA at Bank C “for the benefit of” the account owner, would be perfectly acceptable and would have avoided the entire mess. Direct transfers also have no restrictions on how many can be done per year.

What else went sideways? The $125,000 is no longer in a tax-deferred account. In addition, this person was over 65 and eligible for Medicaid. That eligibility is now in jeopardy due to the bump in earned income. Even if they were over 70 ½ and taking RMDs, traditional IRAs provide some Medicaid eligibility protection. (Depending upon the state, retirement accounts in periodic payment status – i.e., subject to RMDs, – may be treated as an income stream and not as an asset for purposes of Medicaid eligibility.) Now the IRA is gone.

Anything else? Well, the $125,000 was ineligible to be rolled over. It is an “excess contribution” and must be removed from the IRA at Bank C. The good news is that the error was identified prior to the deadline of October 15 of the year following when the excess contribution was made. Form 5329 does not need to be filed and there will be no 6% penalty if the $125,000 (plus earnings) is timely removed.

There was one more problem that this bad rollover created. Remember the original reason behind the second rollover attempt? A search for a higher interest rate on a CD. This person found a nice rate on a 24-month certificate, but had to break the terms of the CD when they removed the excess contribution, resulting in another penalty on top of this rollover calamity.

The account owner was officially sunk.

Always check the pool temperature and depth before diving in! Seek out competent advice from an IRA “lifeguard.” During tax season (and whenever IRA money is in motion), be sure to know the rules to avoid drowning in easily avoidable problems.